The Audit Committee Checklist: Questions to Ask and Items to Review

by Boris Feldman*

If you serve on the Audit Committee of the Board of Directors of a public company, you may feel beleaguered. Everyone is looking to you to stop the wave of corporate restatements. Each month, new requirements are being imposed on you: "do this;" "don't do that;" "sign here." The new rules combine to increase your personal exposure to unprecedented levels.

This article attempts to give you some help. It presents a checklist of questions to ask, and documents to review, in discharging your duties as a member of the Audit Committee. Your CFO may not like this checklist; she may feel that you are micro-managing the Finance Department. The short answer is that, in light of recent internal-controls failures, regulators and the capital markets demand greater Board oversight, even if it is somewhat intrusive. You may not like the checklist, because it will take more time than the cursory Audit Committee review that has been the norm at some companies. If that is your concern, you should consider exiting the Committee. In the new world, investors and regulators expect that Audit Committee membership will take substantial time. "Too busy" will no longer be accepted as an excuse.

The checklist is divided into two major sections: items for review internally; items for review with your outside auditors. Each, in turn, is divided into documents to review and questions to ask. You may find that the checklist provides a useful record of what the Audit Committee examined.

Internal Review

Documents to Review

• Analysis of receivables aging, in form of Days Sales Outstanding, comparing current DSO to prior periods
• Schedule of manual journal entries above a particular level (e.g., $100,000; dependent on size of company), with summary of backup for each entry and senior executive authorizing the entry
• Schedule of significant collection problems, with explanation of reasons for non-payment
• Schedule of returns by customer, including comparisons to prior periods
• Linearity analysis by division or group (showing revenue by each week in the quarter compared to prior periods)
• Analysis of major revenue items that were not "cookie cutter": i.e., significant revenue items not automatically generated by shipping and invoicing system, but which required some judgment as to accounting treatment
• Schedule of adjustments to any items originally booked in a previous period
• Analysis of changes in reserve accounts (particularly bad debt, excess/obsolete inventory, and returns reserves; accounts-payable accruals), detailing basis for the reserve amount and explaining changes from formula or rationale in prior periods
• Schedule reflecting current asset-impairment analyses for major assets and changes from prior periods
• Schedule of deviations from standard payment or discount terms on significant transactions
• Analysis of significant sales to new customers, including need for product and whether collectible
• Analysis of differences between GAAP and pro forma results; comparison to pro forma items in prior periods

Questions to Ask

• Note: questions should be directed as appropriate to some combination of CFO, controller, internal auditor, head of credit and collections, and senior financial person in each division or business
• Did you discover or hear rumors of any side-letters? Have any customers balked at paying because they claim to have a special deal?
• Did any of the accounting policies change from prior periods?
• Were there any disagreements within the Finance Department over the proper accounting treatment for any items? Disagreements between Finance and either Sales or the CEO?
• Were there any disagreements between the company and the outside auditors with respect to any accounting decisions?
• Did you reverse or adjust any items previously booked in prior periods?
• If the SEC were to conduct a thorough review of all our transactions for this quarter, which ones would they be most likely to question?
• Are there any accounting decisions that we made this quarter that, if disclosed publicly, might have a significant impact on the stock price? On public perceptions of the condition of our business?
• Were any major factors that impacted our results in this quarter different from what we've discussed with investors in the past? Were there any anomalies in our business this quarter? Are they likely to continue?
• If you ranked our accounting decisions on a scale of conservatism, which decisions do you think are most conservative and which most aggressive?

Review with Outside Auditors

Documents to Review

• Schedule of passed adjustments/items recommended by auditors but declined by company
• Written SAS 71 review report

Questions to Ask

• What is your degree of comfort with the company's accounting decisions? How would you characterize the company's aggressiveness/conservativeness relative to other companies in its industry? Relative to the most widely respected public companies?
• Which accounting treatments present the greatest risk of being questioned down the road?
• Do you think that the company is managing earnings to a particular target, rather than reflecting the true results of operations?
• Which accounting items tended to reflect judgment calls, rather than automatic counting?
• Did you perceive any changes in policies or practices from prior periods?
• Did you make any recommendations or suggestions that management did not accept?
• Are there any employees of the company that you felt were not entirely candid and responsive to you?
• If you were our internal chief accounting officer, would you have made any accounting decisions differently?
• Were there any accounting treatments as to which you consulted your national office?
• How would you assess the internal-controls at the company? What improvements would you make? In what priority?
• Are the accounting personnel capable? Do they have integrity? Does the Finance Department have adequate staffing?
• Did you sense that management directs the Finance personnel in making accounting decisions?
• What procedures did you use to test revenue recognition? Did you find any red flags?
• What procedures did you use to evaluate the reasonableness of reserves and accruals? Where there items as to which you would have reserved a different amount?

*Copyright 2002. Boris Feldman is a member of Wilson Sonsini Goodrich & Rosati, in Palo Alto. This article reflects his views, not his firm's. You are welcome to copy and distribute this article, with express attribution to the author. Revised, August 8, 2002.